“Many investors believe that hedge funds are designed to shoot the lights out, when, in fact, hedge funds are designed to hedge,” says Adam Patti, CEO of IndexIQ, a provider of exchange-traded funds and other products that replicate hedge fund performance.

The other major misconception is that hedge fund strategies are only available to the super rich. While actual hedge funds may be limited to the polo playing set, advisors are using their strategies to reduce risk in the portfolios of everyday clients.

“Conceptually, I do think that investing in these hedge fund-like instruments does make sense,” says Robert Wander, founder of Wander Financial Services, a financial planning and employee benefits consulting firm in New York. Although Wander says he would not recommend such products for a retiree taking distributions, he sees these alternative investments as attractive for just about everyone else. With globalization increasing market correlations, Wander likes the ability to buy “an uncorrelated type of investment.”

'ADDITIONAL DIVERSIFICATION'

For years, Wander used managed futures mutual funds to diversify client portfolios. He recalls that for a long time, investments in managed futures seemed to be almost an absolute return strategy.

“When you had severe downturns in the market, you often times had positive results,” says Wander. And futures funds even held fairly steady when the stock market soared.

In recent years, however, managed futures have lost their charm, posting losses as other asset classes did well. Wander is now moving toward a mix of hedge-fund-type strategies, including long/short, arbitrage, and global macro. “When you blend in some of these other strategies, within that asset class, you get additional diversification,” he says.

HEDGE FUND REPLICATORS

Adam Patti’s firm seeks to provide some of that diversification through four ETFs that track various hedge fund styles. “You can actually boil down hedge fund returns to a series of different asset class exposures,” he says.

All of IndexIQ’s hedge-fund-replicating ETFs use passive rules-based strategies. The firm looks at hedge fund returns, determines which combination of broad asset classes would create that return profile and uses other ETFs as proxies for those asset classes. The result, says Patti, is a set of institutional-style strategies in very liquid, transparent packages.

The firm’s flagship product, IQ Hedge Multi-Strategy Tracker ETF (QAI), a fixed-income alternative, was launched a little more than five years ago. Over that time period, says Patti, its returns were slightly better than the HFRI Fund of Funds Composite Index.

“Everyone should have an allocation to alternatives,” says Patti. “The question is: how?”

Joseph Lisanti, a Financial Planning contributing writer in New York, is a former editor-in-chief of Standard & Poor’s weekly investment advisory newsletter, The Outlook.